Why low oil prices are bad for you

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Despite the recent cheerleading from Ben Broadbent, the prolonged fall in the price of oil is bad for the UK economy. This is because – like most economists – Broadbent misunderstands the economic fundamentals.

The accepted wisdom is that low oil prices are the equivalent of a tax cut for consumers. The assumption is that almost everyone will spend the difference between the high and low oil prices into the economy. But hang on just a minute Mr Broadbent… there is no law that says that low prices have to be passed on. Indeed, most fuel retailers were slow to cut their prices; and none are promising to hold them down for long. The energy companies have been even worse, opting to hang onto the fall in the price of gas rather than lower customers’ bills.

In fact, companies hanging on to the savings is the least of the problem. More worrying is what we have done with those savings that we did enjoy. Once again, there is no law that says people have to spend the savings they get on fuel. Since most people are smart enough to figure out that what goes down is likely to go back up – either because the oil glut will give way to an oil shortage, or more likely because (taking a lead from Obama) George Osborne will increase the duty on fuel – they have chosen either to pay off debt or to save money for the future. High street sales in the run up to Christmas were dire, and there is little sign of an increase since.

Both saving and paying down debt are deflationary since they remove money from the economy. So not only are those in receipt of savings on fuel not spending them, by taking money out of the economy, they are helping to slow general spending across the economy.

Meanwhile, the downside of low oil prices is that capital investment in future extraction and exploration has plummeted. Almost every country and all of the oil companies in the world are losing money at the current price. What money they have is going to servicing outstanding debt and paying dividends to maintain investor confidence. The future, meanwhile, is being sacrificed.

We are witnessing in the real economy what Richard Heinberg has called the death of the Goldilocks Zone; the price zone in which oil companies can make a profit without undermining consumer demand. Moreover, with global recession looming and stock market falls accelerating, the world may never get back to the point where people can afford $100 per barrel oil.